How Pre-Payment Penalties Work
If you decide to break your mortgage contract early or pre-pay more than what your mortgage lender allows, you will be charged a prepayment penalty. Prepayment penalties are calculated two ways.
If you are in a variable rate mortgage, the penalty will be only three months' worth of interest; If you are in a fixed-rate mortgage, the cost will be the greater of:
If you are in a variable rate mortgage, the penalty will be only three months' worth of interest; If you are in a fixed-rate mortgage, the cost will be the greater of:
- 3 months worth of mortgage interest; OR
- Interest for the remainder of the term calculated on the amount you prepay. The way we calculate this amount is using the IRD also known as the Interest Rate Differential.
Prepayment Penalty: Scenario 1
Here's an example of a three-month interest pre-payment penalty on a variable rate mortgage.
$200,000 mortgage balance @ 5 per cent
20 months remaining in the term
Monthly payment: $833.33
3 month interest prepayment penalty $2,500
$200,000 mortgage balance @ 5 per cent
20 months remaining in the term
Monthly payment: $833.33
3 month interest prepayment penalty $2,500
Prepayment Penalty: Scenario 2
Here's an example of the Interest Rate Differential calculated on a fixed rate mortgage.
$200,000 mortgage balance @ 5 per cent
Interest Rate Differential is 1 per cent (The current interest rates at the time of prepayment is 4%).
Monthly IRD amount is $166.66.
$166.66 x 20 months remaining = $3,333.33.
$200,000 mortgage balance @ 5 per cent
Interest Rate Differential is 1 per cent (The current interest rates at the time of prepayment is 4%).
Monthly IRD amount is $166.66.
$166.66 x 20 months remaining = $3,333.33.
The Difference In Penalty Between Fixed Rate And Variable Rate Mortgages
As you may have noticed, a fixed rate mortgage can be more costly to exit. Each lender can calculate their IRD in different ways. Major banks base their IRD on the Bank of Canada's posted rates. This could mean even higher penalties.
Major banks have the most costly method of calculating pre-payment penalties. They use the Bank of Canada's posted rate in their formula or calculation. As mortgage brokers, we work with lenders who have less expensive pre-payment options to save you money in the event your life situation changes and you need to break your mortgage contract early.
I can help you determine your prepayment penalty. Give my office a call today and I'll walk you through it, free of charge.
Major banks have the most costly method of calculating pre-payment penalties. They use the Bank of Canada's posted rate in their formula or calculation. As mortgage brokers, we work with lenders who have less expensive pre-payment options to save you money in the event your life situation changes and you need to break your mortgage contract early.
I can help you determine your prepayment penalty. Give my office a call today and I'll walk you through it, free of charge.
